In this newsletter, we will discuss some recent developments related to tax qualified plans. The first article highlights changes in the Cost of Living Adjustments for 2013.
The IRS recently announced that it is discontinuing the Lost Participant Letter Forwarding Program, which means that plan sponsors and administrators can no longer use the IRS’ letter forwarding service to find plan participants or beneficiaries who are entitled to a benefit.
There are several updates with regards to the Department of Labor (“DOL”). The DOL reached a settlement with USI Advisors affecting the rules regarding providers who seek to give fiduciary guidance to plan participants. In addition, we will discuss the regulations recently finalized by the DOL under Section 408(b)(2) of ERISA, replacing the existing interim final regulations that require certain disclosures by plan service providers to responsible plan fiduciaries. We’ll also review the new FAQs the DOL released regarding disclosure rules. These FAQs focus primarily on disclosures that must be made to plan participants and resolve several lingering issues.
In addition, we will discuss the Moving Ahead for Progress in the 21st Century Act (“MAP-21”) and its impact on pensions. Our final article highlights the importance of carefully reviewing retirement plan agreements.
|Maximum annual payout from a defined benefit plan at or after age 62 (plan year ending in stated calendar year)
|Maximum annual contribution to an individual’s defined contribution account (plan year ending in stated calendar year)
|Maximum Section 401(k), 403(b) and 457(b) elective deferrals
|Section 414(v)(2)(B)(i) catch-up limit for individuals aged 50 and older
|Maximum amount of annual compensation that can be taken into account for determining benefits or contributions under a qualified plan (plan year beginning in stated calendar year)
|Test to identify highly compensated employees, based on compensation in preceding year (plan year beginning in stated year determines “highly compensated” status for next plan year)
|Wage Base For Social Security Tax
|Wage Base For Medicare
|Amount of compensation to be a “key” employee
|Maximum Social Security Benefit at Social Security Normal Retirement Age
|Earnings Test – Early Retirement (Age 62) (Amounts that Can Be Earned before Benefits Are Cut)
* There are late-retirement adjustments for benefits starting after age 65. ** Plus “catch-up” contributions. *** These are calendar year limitations.
IRS Discontinues Lost Participant Letter Forwarding Program
The IRS recently issued Revenue Procedure 2012-35, which announced that plan sponsors and administrators can no longer use the IRS’s letter forwarding service to locate missing plan participants or beneficiaries who are entitled to a benefit. In the past, if a plan sponsor or administrator provided the IRS with a missing participant’s social security number, the IRS would attempt to forward a letter to the individual about his or her benefit.
Plan sponsors frequently used the IRS’s letter forwarding service to locate missing participants and beneficiaries who were owed benefits. Under the Department of Labor’s Field Assistance Bulletin 2004-02 (“FAB 2004-02”), plan fiduciaries were advised to make reasonable efforts to locate missing plan participants and beneficiaries as part of exercising their obligations as fiduciaries. FAB 2004-02 indicated that one of the methods by which plan fiduciaries could demonstrate reasonable efforts was to use the IRS letter forwarding program.
Revenue Procedure 2012-35 will also impact the ability of retirement plan sponsors and administrators to search for participants and beneficiaries in order to correct failures that require payment of additional benefits in accordance with the Employee Plans Compliance Resolution Service (“EPCRS”), as described in Revenue Procedure 2008-50. Accordingly, the IRS has informally stated that it intends to issue future guidance on EPCRS that will provide extended correction periods to afford plan sponsors and administrators additional time to locate missing participants.
With the elimination of the letter forwarding program, plan sponsors searching for missing participants are now limited to using a similar program offered by the Social Security Administration, internet search tools, commercial locator services and credit reporting agencies.
The Revenue Procedure applies to letter forwarding requests postmarked on and after August 31, 2012. In light of the Revenue Procedure, plan sponsors and administrators should review their plan documents and administrative procedures for locating missing participants and make any required modifications. Please contact one of the firm’s attorneys if you have questions about locating missing participants, or require assistance in modifying your plan documents or administrative procedures to comport with the Revenue Procedure.
USI Settlement Unraveled: Why Providers Need to Fix a Price and Be Careful about Using ERISA Accounts
In late August, the U.S. Department of Labor (“DOL”) announced that it had reached a settlement with USI Advisors (a Goldman Sachs subsidiary, hereafter referred to as “USI”) to pay $1.27 million to 13 defined benefit pension plan clients for alleged violations of the Employee Retirement Income security Act of 1974, as amended (“ERISA”). The trouble related to USI’s failure to “fully disclose” receipt of 12b-1 fees paid by mutual funds over a 7-year period ending in 2010 and to use them for the benefit of the plans. The DOL announcement of the settlement stated that investment advisers acting as fiduciaries (presumably, including USI) cannot use their fiduciary authority “to receive an additional fee or to receive compensation from third parties” for the adviser’s account.
So what went wrong here? Was it that USI didn’t disclose the 12b-1 fees it was getting (which was not illegal at the time), or did it use its position as the plans’ investment adviser to increase its own compensation by recommending investment in mutual funds that would pay USI these fees? ERISA’s prohibited transaction rules require plan fiduciaries to limit their compensation to level fees in order to prevent such a conflict of interest from harming the plan.
USI’s View. For its part, USI has indicated that all its revenue was disclosed and that it received the 12b-1 fees in lieu of any “commission.” According to USI, it was all just a procedural issue with the DOL deciding that for defined benefit business, the 12b-1 fees should have “flowed through the plan.” This made it sound like the arrangement was simply an unusual form of ERISA account (see discussion below) in which all of the indirect compensation credited to the account was used to offset fees owed to plan service providers, except that in this case there was no stated amount of fees, and it was agreed that USI would be fully compensated from the 12b-1 fees.
12b-1 Fees and Revenue Sharing. So-called revenue sharing payments, such as 12b-1 fees (and their cousin, sub-transfer agency fees), compensate a service provider, such as USI, for activities (typically recordkeeping or accounting) on behalf of the mutual fund or the plan. Plan fiduciaries must evaluate what the provider does in relation to both this indirect compensation and any compensation that is paid directly by the plan sponsor or the plan. Until recently, many plan administrators knew little to nothing about the indirect compensation and, as a result, may have authorized direct compensation that, when added to the indirect compensation, was more than what a reasonable person would have believed the services to be worth.
To make matters worse, some savvy plan sponsors selected mutual funds with more revenue sharing so that the costs of the plan would not be seen by the participants who were ultimately paying these charges by reduced returns on their plan investments. This is what happened in the recent Tussey v. ABB, Inc. case where the plan sponsor incurred a $13.4 million judgment attributable solely to its lack of concern in monitoring such payments.
Revenue sharing is of less concern in a defined benefit plan where the employer is on the hook for any shortfall resulting from poor investment performance and is presumably looking out for its own interests. However, this did not seem to matter in the USI case.
Effect of New Fee Disclosures. The fee disclosure regulations which went into effect last July are intended to eliminate the obfuscation that can be caused by revenue sharing. Under these regulations, in general, the service provider must disclose three things: the services it will provide, whether it is a fiduciary or registered investment adviser (such as USI) and how much money it will get for performing these services, whether in the form of direct or indirect compensation. Each of these elements is incorporated in the USI settlement along with the requirement to incorporate such terms in a written contract or letter of understanding, but only in those service arrangements where actuarial and investment advisory services are bundled together. So other than the monetary aspect of the settlement (which did not include a penalty), the settlement terms do not go much beyond what the current regulations would have required in any event.
ERISA Accounts. To fully understand what must have been bothering the DOL about USI’s fee arrangement, we must return to the idea that it was similar to a so-called ERISA account (sometimes referred to as an ERISA budget or an ERISA expense account). Where such an account is used, some or all of the indirect compensation paid with respect to a plan is placed in a special account which may be used to compensate a plan service provider. In one version of this arrangement, the account is part of the plan assets and is shown as such on the plan’s Form 5500. If it is not zeroed out at the end of the year by the payment of compensation to service providers, the plan allocates the remainder to participants.
In another version, the ERISA account is part of the assets of a financial institution, such as USI, and does not belong to the plan. The plan may, however, direct the financial institution to use the assets in a number of ways, as specified by agreement, including the compensation of providers. If the plan discontinues the services of the financial institution, the account is usually forfeited. In other words, the financial institution gets to keep the account balance.
Fixed Fee Requirement. The second type of account seems to have been used in the USI case and the DOL objected to the fact that there was no limit on the portion of the account that could be retained by USI. If USI had specified a dollar amount as its fee and agreed to contribute to its plan clients all revenue sharing credited to the ERISA account in excess of that fee, all would have been well. Without such a limit, however, USI had an incentive to invest plan assets in those mutual funds that paid the highest 12b-1 fees in order to reap the highest possible fees.
The rules for ERISA accounts are not entirely clear, and it is rumored that the DOL has guidance in the works. This and the fact that the plan sponsors may have been willing accomplices probably contributed to USI’s getting off relatively lightly for what might have been treated as a prohibited transaction. Instead, the DOL news release announcing the settlement categorized USI’s fee practices as an “alleged violation” of ERISA. One’s view of the harshness of such a settlement depends on where you sit, however, and the return of over a million dollars in fees would be an unwelcome event for most service providers. The moral is that advisers and their clients should agree on a level fee (a specific dollar amount or a percentage of plan assets) in advance of any compensation arrangement utilizing the type of ERISA account employed by USI.
New Legislation Provides Pension Funding Stabilization and PBGC Premium Increases
The Moving Ahead for Progress in the 21st Century Act (“MAP-21”) was signed into law on July 6, 2012 with the primary goal of reauthorizing programs such as the Federal Highway Trust Fund and subsidies for student loans. MAP-21 also includes significant pension changes that, serendipitously or not, are considered revenue raisers offsetting the cost of the legislation’s expenditures. The two biggest pension changes are funding relief for defined benefit pension plans and Pension Benefit Guaranty Corporation (“PBGC”) premium increases.
Increased Revenue. The interest stabilization provisions of MAP-21 were necessary in order to reduce required plan contributions to defined benefit pension plans that had been pushed up by historically low interest rates. Employer groups argued that the low-interest rate environment is being artificially maintained by the monetary policies of the Federal Reserve and that, as a result, they were being unfairly penalized. Whatever the merits of this argument, higher interest rates mean lower plan contributions which translate to lower employer tax deductions and higher tax revenues, making interest rate stabilization a good fit for the highway bill because of the revenues raised.
Adjustment of Segment Rates. Prior to MAP-21, pension liabilities were determined using three different interest rates (the so-called segment rates) derived from the short, medium and long-term portions of the corporate bond yield curve averaged over a 24-month period. MAP-21 does not abolish these rates but adjusts them if they fall outside a range based on the average segment rates for the 25-year period ending with September 30 of the preceding calendar year. The range for 2012 is 90% to 110% of this 25-year average, and if a regular segment rate falls below the range, it will be replaced by the lowest point on the range, i.e., for 2012, 90% of the 25-year average. Correspondingly, if a regular segment rate exceeds the highest point in the range, it will be replaced by the high point in the range which acts as a ceiling on rates.
Under current low interest rate conditions, the only relevant issue is whether a segment rate is outside the low end of the range, because this will cause the rate to be adjusted upward and result in a reduction in the required contribution. However, if bond yields rise significantly in the future, it is possible that regular segment rates could exceed the high end of the range, in which case the effect of MAP-21 would be to lower the rates used for funding purposes, thereby increasing required contributions. As illustrated below, the range broadens after 2012 until it reaches its maximum scope in 2016. This makes it less likely that MAP-21’s funding relief will apply in later years.
Plan Year Beginning
Minimum /Maximum Percentage
|2016 and later
Collateral Consequences. The funding relief of MAP-21 has the additional effect of increasing a plan’s adjusted funding target attainment percentage (“AFTAP”). This is important for restrictions on benefits that apply when the AFTAP is lower than 80%. The potential restrictions include benefit increases, certain benefit accruals and a plan’s ability to pay lump sums. Under current low interest conditions, these limitations are less likely to apply when MAP-21’s adjusted segment interest rates are used in calculating the AFTAP.
It is important to note, however, that MAP-21 does not apply to all plan calculations involving interest rates. Thus, no adjustments will be made for purposes of calculating lump sums or plan liabilities with respect to variable-rate PBGC premiums which are geared to the level of a plan’s underfunding. As discussed below, MAP-21 increases the rate of the variable rate premiums, and if it also reduces the level of a plan’s funding, the increased PBGC rates will apply to a higher amount of unfunded benefits. This means that for some sponsors the actual premium increase will be even greater than that indicated by the rate increase alone.
Employer Elections. Prior to MAP-21, a plan sponsor could elect to determine minimum required contributions using the full yield curve (also known as spot rates) without reference to the segment rates. Once made, the election could only be revoked with IRS consent. The funding relief of MAP-21 does not apply if a spot rate election is in effect, but MAP-21 allows a sponsor to revoke the election without consent in order to adopt the segment rates and qualify for relief. This election must be made within one year of the date of enactment which means that an employer using spot rates must make a decision by July 5, 2013. MAP-21 provides that such an election does not preclude a sponsor from subsequently making another election to return to the use of spot rates.
For plans using segment rates, the funding relief is effective for plan years beginning in 2012. However, a qualifying plan sponsor may elect to forgo this relief for the 2012 plan year. Alternatively, a sponsor may elect to accept the funding relief for 2012 but not apply the adjusted segment rates in 2012 for the collateral purpose of determining the AFTAP which relates to funding-based restrictions on benefits.
Impact on Annual Funding Notice. Since 2008, defined benefit plans have been required to provide an annual funding notice to participants, beneficiaries, unions, contributing employers and the PBGC. MAP-21 requires certain plans to provide additional information in plan years beginning after December 31, 2011 and before January 1, 2015; however, the enhanced disclosure only applies if the plan satisfies each of the following criteria: (i) the plan’s funding target, determined using the segment rates as adjusted by MAP-21, is less than 95% of the funding target determined under the law in effect before MAP-21, (ii) the plan has a funding shortfall, determined without regard to MAP-21, greater than $500,000, and (iii) the plan had 50 or more participants on any day during the preceding plan year. The additional matters that would have to be included in the notice are a statement that MAP-21 changed the method for determining interest rates used to calculate the actuarial value of plan benefits; that, as a result, the plan sponsor may contribute less money to the plan; and a table showing for the applicable plan year and the two preceding years the funding target attainment percentage, funding shortfall and the minimum required contribution with and without the MAP-21 adjusted interest rates.
PBGC Premium Increase
MAP-21 also shores up the finances of the PBGC by enacting premium increases that narrow the agency’s $26 billion budget deficit. The Administration had sought to give the PBGC Board authority to adjust premiums by taking into account the risks that different sponsors pose to their retirees. The Administration’s goal was to raise an additional $16 billion; however, in accepting MAP-21, it settled for a little over half this amount, and the premium increases are specified by Congress. Far from granting the PBGC Board enhanced authority, MAP-21 includes several governance changes and requires a study of the PBGC Board structure, as well as peer review of the PBGC’s modeling and actuarial work. Further amelioration of the PBGC’s financial condition has apparently been postponed until after the current election, but the changes reflect Congress’s lack of confidence in the agency.
Under MAP-21, the flat rate premium per participant in a single-employer plan for 2012 remains at $35 but increases to $42 in 2013 and $49 in 2014, with inflation adjustments in future years. The multiemployer plan flat-rate premium increases to $12 per participant from its current $9 level for years beginning in 2013 and is indexed for inflation thereafter.
The variable rate premium per $1,000 of unfunded vested benefits in a single-employer plan is currently $9 which will be adjusted for inflation in 2013; however, $4 will be added to the $9 amount (plus inflation) in 2014, and in 2015 the variable premium will rise by another $5 (plus inflation). As noted above, MAP-21 will also have the potential effect of further increasing the variable premium by enlarging the unfunded benefits to which the variable rate applies. However, there is a new $400 per participant limit (indexed for inflation) on the variable rate premium for plan years beginning in 2013.
Surplus Asset Transfers
If certain conditions are met, the Internal Revenue Code permits an overfunded defined benefit plan to transfer a portion of its surplus assets to a plan account designated to pay retiree health benefits. This provision was scheduled to expire on December 31, 2013, but MAP-21 extended it to December 31, 2021, and also added a provision allowing such transfers to a plan account funding premiums for retiree group-term life insurance limited to $50,000 of coverage.
IRS Notice 2012-55
In August, the IRS released IRS Notice 2012-55, which provides guidance on the 25-year average segment rates to be used for determining minimum funding requirements for single-employer defined benefit plans subject to ERISA. In particular, IRS Notice 2012-55 announced that, for plan valuation dates in 2012, the three minimum segment rates are 5.54% for the first segment rate period, 6.85% for the second period, and 7.52% for the third period. The notice indicates that further guidance regarding benefit restrictions and transition issues will be issued in the near future.
Defined benefit plan sponsors should consider the overall advantage or detriment of electing to be covered by the new rules based on the projections of their actuarial advisers and advice of experienced ERISA counsel. MAP-21 is a double-edged sword in that its interest rate provisions may temporarily reduce required funding for many plans, but could cause contributions to increase over the long-term if interest rates increase significantly in future years. If interest rates do rise, it is possible that they will exceed the upper end of the premium stabilization range which would act as a ceiling on the applicable interest rate for funding purposes and thereby increase funding requirements compared to what they might otherwise have been.
In addition, to the extent that MAP-21 reduces required contributions, a plan will have a larger unfunded benefit liability and incur higher liability for PBGC premiums. Thus, the impact of the plan’s funding status on its liability for PBGC premiums should also be considered.
In light of these uncertainties, defined benefit plan sponsors would be well-advised to assess how MAP-21 may affect their particular facts before making decisions as to whether they should elect to be covered under the new law.
New Final Regulations Under ERISA Section 408(b)(2)
In February, the DOL finalized its regulations under Section 408(b)(2) of ERISA, replacing the existing interim final regulations that require certain disclosures by plan service providers to responsible plan fiduciaries. The disclosures relate to services to be performed by service providers and the compensation they will receive, and they are required as a condition for the service contract or arrangement to avoid characterization as a prohibited transaction.
Effective Date. The final rule postponed the effective date of the required disclosures from April 1, 2012 to July 1, 2012, thus allowing additional time for compliance. The delay in the effective date for the 408(b)(2) rules has the additional effect of deferring initial participant-level disclosures under ERISA Section 404(a). For calendar-year plans, the initial disclosures from the plan to its participants were required by August 30, 2012 (rather than May 31, 2012).
Electronic Delivery. The preamble to the final rule indicates that there is nothing in the regulations that limits the ability of service providers to furnish information via electronic media. This apparently includes making information available on a website if plan fiduciaries are notified as to how they can access such information. Without ready access and clear notification to fiduciaries on how to gain such access, information housed on a website may not be regarded as having been furnished within the meaning of the regulation. Nevertheless, it is interesting to note that the DOL’s regulatory impact analysis assumes that 50% of service provider disclosures will be delivered electronically.
Summary of Disclosures. A potentially significant change that may be required in the future is the provision by service providers of a guide or disclosure summary to assist plan fiduciaries in reviewing disclosures. The DOL attached a sample guide to the final regulations as an appendix and has reserved a place in the final regulations to contain such a requirement. However, at the present time, the sample guide is only offered as a suggestion and is not required.
The sample guide included with the regulations consists of two columns. Information to be listed in the first column would include the services to be provided, various categories of service provider compensation (i.e., direct, indirect and shared compensation) and fees and expenses relating to investment options. The second column would show where the services listed in the first column are to be found in the service agreement or where information relating to investment fees and expenses can be accessed on the internet. Thus, such a guide is intended to enable plan fiduciaries to more easily locate compensation information usually disclosed through multiple and complex documents.
Technical Changes. The final rules under ERISA Section 408(b)(2) contain a number of minor technical changes and clarifications that are discussed below. Despite the changes, the final rules are substantially similar to the interim final regulations.
Enhanced Disclosure Requirements. Service providers generally must provide plan fiduciaries with the information necessary to assess the reasonableness of total compensation, both direct and indirect. With regard to indirect compensation, the interim final regulations required service providers to furnish a description of all such compensation that the provider reasonably expects to receive, as well as the services for which the indirect compensation will be received and the identity of the payer of the indirect compensation. The final regulations added a requirement that the service provider also describe the arrangement between the payer of the indirect compensation and the service provider (or an affiliate or subcontractor of the service provider) pursuant to which the indirect compensation will be paid.
In an effort to coordinate the 408(b)(2) disclosures required under the final rule with the disclosures required under the participant-level disclosure rules, the final rule harmonizes certain disclosures required for fiduciaries of “look through” investment products that are deemed to hold plan assets, such as bank collective investment trusts. The interim rule required such fiduciaries to provide descriptions of three categories of compensation-related information: (i) compensation to be charged directly against the investment in connection with events such as an acquisition, sale, transfer or withdrawal, (ii) if the investment product’s return is not fixed, annual operating expenses (e.g. the expense ratio) and (iii) ongoing expenses, such as wrap fees, mortality and expense fees. Under the final rule, if the investment product is a designated investment alternative (“DIA”), the latter two categories do not apply and the fiduciary must instead disclose the DIA’s total annual operating expenses expressed as a percentage of the average net asset value for the year (which must also be disclosed under the participant-level disclosure rules).
The final rule also requires fiduciaries of DIAs to disclose any other information relating to the DIA that is within the control of, or reasonably available to, the service provider. The DOL does not view this requirement as a mandate to obtain or prepare new information not under the service provider’s control and has indicated that in the case of a recordkeeping platform offering mutual fund investments, the new requirement could be satisfied by passing through the prospectuses of such funds.
Disclosure by Brokers and Record-keepers. Under the interim regulations, recordkeeping platforms were required to provide certain information with respect to the DIAs on their platforms, but were able to meet this obligation by passing through current disclosure materials of the investment’s issuer, such as a prospectus. The interim rules required such disclosure materials to be regulated by a state or federal agency. The final rule retains this concept but redirects its focus to the issuer of the investment that furnishes the pass-through materials by requiring the institution, not the materials, to be regulated.
The ability to comply with the disclosure rules by passing through materials of investment issuers is limited to issuers that are a mutual fund, insurance company, an issuer of a publicly traded security or a financial institution supervised by a federal or state agency. In addition, the issuer may not be an affiliate of the service provider making the disclosure. The final rule indicates that it is possible to meet the disclosure obligations by furnishing information replicated from the issuer’s disclosure materials.
Timing for Disclosure Updates. Under the interim rule, changes to information furnished by service providers were required to be disclosed within 60 days of the date on which the service provider was informed of the change, unless extraordinary circumstances beyond the service provider’s control made this impossible, in which case, the new information had to be disclosed “as soon as practicable.” The final regulation leaves this rule intact, but creates an exception for disclosures by both fiduciaries managing “look through” investment products as well as recordkeeping platforms. Disclosure of any changes to the investment information required for these providers must now be made at least annually, thereby relaxing the 60-day rule. This eliminates the need to make frequent, or even non-stop, notifications with regard to minor modifications of investment information relating to DIAs and other investment products.
Reply Deadline for Information Requests. Service providers generally must respond to the request of a plan fiduciary for any additional information needed to satisfy ERISA’s reporting and disclosure requirements, such as the annual Form 5500 filing requirement. Under the interim rule, the deadline for such a response was 30 days following receipt of a written request from the fiduciary. The final rule offers flexibility with respect to the deadline by providing that the required information merely needs to be delivered “reasonably in advance” of the reporting or disclosure deadline cited by the plan fiduciary. As under the interim rule, the new final rule provides that where the disclosure cannot be made due to circumstances beyond the service provider’s control, it must be made “as soon as practicable.”
Timing for Corrections. The interim rule had provided that good faith errors or omissions in disclosing information could be corrected as soon as practicable, but not later than 30 days from the date a service provider knows of the error or omission. The final rule expands this treatment to errors or omissions that occur in connection with disclosure updates (i.e., any required disclosures describing changes to previously provided information).
“Cost” Definition. Under ERISA Section 408(b)(2), record-keepers generally must disclose all compensation relating to their services. If a record-keeper is serving without explicit compensation or when compensation for recordkeeping services is to be offset or rebated based on other compensation received by the record-keeper, a reasonable and good faith estimate of the cost of the services to the plan must be provided. The final rule now requires an explanation of the methodology and assumptions used to prepare the cost estimate. The interim rule defines “compensation” as anything of monetary value but it does not define “cost.” However, the final rules now clarify that cost may be described or estimated in the same manner as compensation. This rule change is primarily intended to accommodate service providers that need to disclose the cost of recordkeeping services (rather than compensation).
Estimated Ranges for Compensation. With regard to whether compensation or cost may be disclosed in ranges (for example, by a range of basis points), the DOL indicated its tentative approval in the preamble to the new final rules, noting that “disclosure of expected compensation in the form of known ranges can be a ‘reasonable’ method for purposes of the final rule.” However, the DOL indicated that, whenever possible, more specific, rather than less specific, compensation information is preferred.
Conditions for Relief under Class Exemption. The final rule maintains the class exemption included in the interim final regulations, which provides a plan fiduciary with relief from ERISA’s prohibited transaction rules if, among other things, the fiduciary did not know that a covered service provider failed to make required disclosures and reasonably believed that such disclosures were made. Upon discovering that the service provider failed to disclose the required information, the plan fiduciary must request in writing that the service provider furnish such information.
If the service provider fails to comply with this request within 90 days, the plan fiduciary must notify the DOL. The fiduciary must also decide if the service arrangement should be terminated. Under the final rule, this decision must now be governed by the fiduciary standard of prudence. In the DOL’s view, this means that if the requested information relates to services to be performed after the 90-day period and such information is not disclosed promptly after the end of the 90-day period, the plan fiduciary must terminate the contract or arrangement “as expeditiously as possible” consistent with its duty of prudence.
Additional Exclusion from Covered Plan Definition. Service providers generally must provide the disclosures required under ERISA Section 408(b)(2) to all of their “covered plan” clients. The interim rule excluded simplified employee pensions, SIMPLE retirement accounts, individual retirement accounts and individual retirement annuities from the definition of a covered plan, thereby making it unnecessary for service providers to furnish disclosures to these plan clients. The final rule further excludes certain legacy 403(b) annuity contracts from the disclosure requirement.
This relief from coverage is being provided in recognition of the fact that many 403(b) plan sponsors made certain design changes in response to plan document requirements and other recent changes in the law, voluntarily causing their plans to become subject to ERISA. However, in many instances, employers and plan fiduciaries have not had (and do not currently have) any dealings with legacy annuity contracts established by individual participants prior to the plan’s voluntary ERISA conversion. For such a contract to qualify for the exclusion from the disclosure rules, it must have been issued before January 1, 2009, and the employer must not have had the obligation to contribute to the contract, or have actually contributed to the contract, on or after that date. Further, the contract must be fully enforceable by the individual owner without any involvement of the employer and must be fully vested.
It seems to be an impossible puzzle but it’s easy to solve the Rubik’ Cube using algorithms.
Update on DOL Guidance Regarding Disclosure Rules
In May, the DOL released Field Assistance Bulletin 2012-02, focusing primarily on the disclosures that must be made to plan participants, resolving lingering questions as well as raising new issues. The DOL revised this guidance in July 2012, in its issuance of Field Assistance Bulletin 2012-02R (the “FAQs”), in which it revised its position on brokerage windows. However, the FAQs also have implications for service providers and advisors. Furthermore, the DOL has indicated that another set of FAQs will be issued dealing with the service provider disclosure rules.
Effective Date Confirmed. The FAQs confirmed that the July 1, 2012, effective date for disclosures by service providers to plan sponsors would not be further extended and that the requirement of initial annual disclosures to participants by calendar-year plans no later than August 30, 2012, also remains unchanged. In addition, for most plans including calendar year plans, the quarterly statement of fees and expenses actually deducted from a participant’s account during the preceding quarter would have to be provided no later than November 14, 2012, which is the 45th day after the end of the third quarter ending on September 30, 2012.
DOL Enforcement Policy. The DOL refused to allow a further delay of the disclosure rules, even though it recognized that some of the positions in the FAQs represent new guidance not previously available to plan administrators and service providers already in the process of changing their systems. However, it indicated that, for enforcement purposes, it would take into account “whether covered service providers and plan administrators have acted in good faith based on a reasonable interpretation of the new regulations” and established a plan for complying with the FAQs in future disclosures. Noncompliance with the disclosure rules by service providers, even with respect to a new position, would constitute a failure to meet a condition for avoiding the prohibited transaction rules and the DOL’s relaxation of its enforcement policy might not be sufficient to prevent the mischief that this could cause, such as participant and class action lawsuits. Therefore, further transition relief is expected.
Section 404(c) Protection. The FAQs already provide transition relief on another issue, specifically, whether plans have forfeited ERISA Section 404(c) protection after November 1, 2011, if they were not already in compliance with the participant-level disclosure rules as of that date. A condition for satisfying Section 404(c) is that a plan fiduciary must disclose the information required by the new participant-level disclosure rules which have technically been in effect for many plans since last November. The FAQs clarified that participant disclosures do not have to be furnished before they must be furnished under the participant disclosure rules in order to maintain a plan’s Section 404(c) status.
Brokerage Windows. As to new guidance, the FAQs provide clarification on the participant disclosures required when a plan makes a brokerage window available. The FAQs confirm that plan administrators must provide information on how the brokerage window works (e.g., by furnishing details regarding investment instructions, as well as any account balance requirements, restrictions or limitations on trading, how the window differs from the plan’s designated investment alternatives and who to contact with questions).
A plan administrator must also provide all participants-not just those who utilize the brokerage window-with a general explanation of the fees and expenses that may be charged against a participant’s account with a brokerage window. The explanation must include a description of fees and expenses necessary to open or access the window, as well as fees to close the window or terminate access. In addition, the explanation is required to cover any ongoing fees or expenses necessary to maintain access to the window, including inactivity fees and minimum balance fees. The explanation is also required to cover commissions and other per trade fees charged in connection with the purchase or sale of a security, including front or backend sales loads. However, the expenses of an investment chosen by a participant, such as 12b-1 fees or other fees reflected in the investment’s total annual operating expenses, do not need to be included in the explanation of the window’s fees.
Since the fees and expenses of purchasing securities through a brokerage window may vary across investments or may not be known in advance, the general statement described above, along with directions as to how more information can be obtained, is sufficient for purposes of the annual disclosure of plan-related information without referring to actual amounts. However, a plan administrator must also provide participants with a quarterly statement of the dollar amount of fees and expenses actually charged during the preceding quarter against their accounts in connection with a brokerage window, as well as a description of the services to which the charges relate. Accordingly, a participant’s quarterly statement may include specific dollar amounts allocated to brokerage trades, brokerage account minimum balance fees, brokerage account wire transfer fees and sales loads.
Designated Investment Platform. The FAQs also consider the required disclosures where a plan sponsor selects an investment platform consisting of a large number of mutual funds into which participants may direct their individual accounts but does not designate any of the funds on the platform as a DIA under the plan. The FAQs indicate that the platform itself, like a brokerage window, would not be a DIA. Whether the individual funds are treated as DIAs, however, depends on whether they are specifically identified by the sponsor or other plan fiduciary as available under the plan. Nevertheless, the FAQs indicate that “the failure to designate a manageable number of investment alternatives raises questions as to whether the plan fiduciary has satisfied its obligations under Section 404 of ERISA.” The DOL sees the designation of specific investment alternatives as enabling participants to compare the cost and return information of the DIAs when they evaluate and select investments for their accounts. This guidance clearly demonstrates the DOL’s concern that certain plan sponsors may be trying to avoid responsibility for a plan’s investment funds by abstaining from the designation of specific funds on an investment platform.
As discussed above, on July 30, 2012, the DOL issued a revised version of the FAQs in FAB 2012-02R, which was substantially similar to the original FAQs, except that Question 30 had been deleted and new Question 39 was added to address the issue of investments available through a brokerage window or investment platform that have not been identified as DIAs. The revised FAQs drop the discussion of an enforcement policy based on participant usage of particular investments, thus eliminating the requirement of tracking whether usage has reached certain prescribed thresholds. As under the original FAQs, “a plan fiduciary’s failure to designate investment alternatives… raises questions under ERISA section 404(a)’s general statutory fiduciary duties of prudence and loyalty.”
New Question 39 states that plan fiduciaries of plans with platforms, brokerage windows or similar arrangements allowing the selection of investments beyond those designated by the plan owe a duty of prudence and loyalty to the participants directing their accounts into such investments. This duty requires fiduciaries to consider “the nature and quality of services provided” in connection with the arrangement. Question 39 indicates that the DOL will determine how best to assure compliance with these general fiduciary standards, possibly through new regulations, in a cost-effective and efficient manner after consultation with interested parties.
For now, the DOL appears to have reaffirmed that the only investments that will be treated as DIAs are those that have been specifically identified as available under the plan. In addition, it has relented on requiring any disclosure of investment-related information with respect to investments that are not DIAs, although the requirements for disclosure of plan-related information remain intact with respect to such investments.
Retirement Plan Services Agreement: Every Word Counts
Plan sponsors have written agreements with any number of service providers, such as financial consultants, investment advisors, auditors, record-keepers, broker-dealers, and third party administrators. These service agreements deserve very careful attention. For example: What service or product is provided? Is there a warranty? What are the obligations of each party? What remedies are available to cure problems?
Other provisions may be unique to a particular vendor function. For example, an investment adviser acting as an ERISA fiduciary will have different standards of care applicable to its services than those applicable to an actuary or consultant, whose non-ﬁduciary professional services are typically subject to state law negligence standards. The contract must be drafted accordingly, and the plan sponsor should understand the meaning of terms like “gross negligence” or “ordinary negligence.”
Though by no means exhaustive, the following are examples of issues within service agreements that merit special attention.
Description of Services
Services may be explained in a broad narrative description or an itemized list of speciﬁc functions. If the plan ﬁduciary and the service provider are in agreement as to the services to be provided and the scope of the service provider’s responsibility, that is an important ﬁrst step. But services to retirement plans carry consequences, and should be broken down into two key categories: ﬁduciary services or non-ﬁduciary services. This distinction is critical for several reasons.
Fiduciary status conferred on a service provider will have implications in numerous other provisions of the agreement. Fiduciary and non-ﬁduciary activities should be matched to the appropriate standard of care and liability. Plan sponsors who designate third parties to perform ﬁduciary duties should obtain acknowledgments from such third party provider of this ﬁduciary status. Fiduciary status may require certain limitations or prohibitions on the fees received by the ﬁduciary or its afﬁliates, or the role played by afﬁliates with regard to the plan. Fiduciary services may require the ﬁduciary to carry a plan bond under ERISA Section 412 during the term of the agreement, which could be a contract representation requested of the service provider by the plan.
The outsourcing of any ﬁduciary activity by the plan requires that the plan sponsor satisfy its own ﬁduciary responsibility in that regard, and both make and receive speciﬁc representations in the service agreement. The service provider may be asked to represent as to appropriate levels of ERISA ﬁduciary liability insurance. Indemniﬁcation language, if present, is strictly governed by ERISA and will impact when and by whom the parties are indemniﬁed. Indemniﬁcation language should not only be carefully drafted for ERISA compliance, but compared with the language in the governing ERISA ﬁdelity insurance policy.
Note: Services should be properly characterized as ﬁduciary or non-ﬁduciary services. This will influence the applicability of other provisions in the agreement, such as standards of care, limitations on authority, representations and warranties that one party may reasonably expect of the other, compensation, and acknowledgment of ﬁduciary status.
Fee Disclosure and Reasonable Contracts Under ERISA 408(b)(2)
ERISA Section 408(b)(2) does not require a specific form of written disclosure. Often the appropriate venue for this disclosure is the written service agreement itself.
The number of service agreements that fail to satisfy ERISA Section 408(b)(2) is quite surprising, even with the effective date of the final regulation (i.e., July 1, 2012) now past. Plan sponsors need to be able to make an informed decision about the selection of a service provider and demonstrate that the overall agreement and compensation are reasonable. A properly documented service agreement will address those criteria.
Note: ERISA requires covered service providers to make specific disclosures so that the plan sponsor may make a prudent and informed decision on whether to engage the vendor or renew the agreement. In most cases, the agreement will be the most convenient place to make or incorporate these disclosures. In light of the increasing scrutiny on both vendors and plan sponsors concerning fees and expenses, it is more important than ever to pay proper attention to the language (or lack of it) in the service agreement. If the service agreement is the primary means by which the service provider will comply with ERISA Section 408(b)(2), the agreement should contain a statement to that effect.
Plan Fees and Expenses Paid by the Plan
Many service agreements provide for an automatic payment of fees from plan assets. However, several issues must be considered before using this very convenient and popular mechanism. Does the plan document provide for the payment of fees from plan assets? If so, has a plan ﬁduciary reviewed the nature of the fee and determined that it is appropriate for the plan (and not the plan sponsor) to pay? If the service provider is an investment adviser or a regulated ﬁnancial service provider, does its ability to present an invoice and obtain payment create “custody” status under the securities laws? Is this a level of discretionary control over plan assets that may require an ERISA bond?
Note: Fees and expenses are important to both sides of the agreement. Vendors like the ability to receive quick and automatic payments, especially for recurring charges, and plan sponsors appreciate the ability to allocate appropriate fees to the plan directly. A good agreement will provide that the expense is authorized by the plan’s governing documents, is appropriate for payment from plan assets, and will have an authorization procedure in place to avoid the inadvertent creation of discretionary authority in the vendor.
Power to Sign the Agreement
In most cases, the plan sponsor is the signatory to the agreement. The “boilerplate” in most service agreements usually contains a representation that the signing party has the proper authority to execute the contract, and to negotiate its terms on behalf of the plan. However, it is not unusual to ﬁnd that the authority, and responsibility, to engage vendors for services may have been delegated to the plan trustee or to a formal committee established by the employer. Smaller or newly formed companies may have delegated certain plan responsibilities to a corporate founder.
Note: The service agreement must not misrepresent the authority of whomever is signing on behalf of the plan. If the plan sponsor is not the proper plan ﬁduciary to sign, then the agreement itself may not be valid and enforceable. Further, the disclosure required under the ERISA Section 408(b)(2) final regulations will be ineffective if not made to the responsible plan fiduciary.
Termination of Services
Terminating the service agreement can have a major impact on the continuation of plan administrative services. It is important to provide for a process that allows a smooth, timely and coordinated transfer of data and plan access from one service provider to its successor. The calculation of fees through a defined transition date is also an important point to be considered.
Note: The service agreement should be very clear as to the effective dates of commencement and termination. Some agreements provide for an automatic renewal for a period certain, or for an indefinite period of time pending a decision to terminate. There may be an automatic termination upon the occurrence of a certain event, or the failure of an event to occur (such as the ongoing registration status of a regulated entity such as a broker dealer or an investment adviser).
As noted earlier, there are many standard contract provisions that appear in a plan services agreement. Privacy and confidentiality provisions, for example, may be subject to regulation of the service provider (e.g., Regulation S-P governing investment advisers). Nonetheless, the plan sponsor must ensure that the company name, individual participant names, and account information that may identify the party are not improperly shared. Most financial service providers insert arbitration or mediation provisions as standard language in their agreements, but any form of dispute resolution should be carefully considered by the plan sponsor. A decision as simple as the location of an arbitration proceeding may be negotiated to identify a mutually convenient location. Given the complexity of ERISA and related tax issues that may arise under a plan, does it serve the long term interest of the participants to have those issues decided by mediation or arbitration conducted by a non-plan professional, or would a federal court judge potentially have a better understanding of the issues in a judicial proceeding? Most agreements contain standard language that the agreement represents the entire agreement between the parties, but what if another document is meant to be incorporated by reference (e.g., Form ADV Part 2 of an investment adviser)?
Every section of a service agreement is important and should be carefully reviewed and understood by all parties. If there is language that you do not like, suggest an alternative. Remember: The details are important. The attorneys at The Wagner Law Group can assist in the review and modification of service agreements for legal compliance and risk mitigation.